International equity and currency markets are facing a turbulent week as the world's two most powerful central banks meet to consider interest rate levels. After a sharp share sell-off in the US and Europe on Friday, markets are expected to remain nervous ahead of the meetings of the monetary policy committees of the US Federal Reserve and the Bundesbank. Investors took profits on Friday as the market became increasingly nervous that the Bundesbank would raise interest rates at its meeting on Thursday. After a strong bull run this summer, shares in Europe and the US fell back sharply. In London the market suffered its second biggest fall in percentage terms since the crash on black Monday in October 1987 and its biggest one day fall in five years. The FTSE 100 Index dropped 125.5 points or 2.5 per cent to close at 4,868.8.
In New York, the Dow Jones Industrial Average fell 247.37 points or just over 3 per cent to close at 7,694.66, pulled back by a profits warning from consumer products group, Gillette, and a fall in the value of the dollar. In Dublin the ISEQ Index fell 50 points, or 1.35 per cent, with bank shares worst hit.
The falls in Europe on Friday came as many markets were closed for the Assumption Day holiday and trading volume was light. The main markets that were open, Frankfurt and Amsterdam, fell heavily. In Frankfurt, the Dax fell 2.8 per cent, while in Amstersdam the AEX index dropped 4.4 per cent.
The share sell off in the US appears to have been triggered by a fall in the dollar against the deutschmark as investors started to anticipate an increase in German interest rates. The dollar fell almost three pfennigs to DM1.818. Dealers said there was a shift in sentiment about upward movements in German interest rates which prompted dollar selling by hedge funds.
The market was concerned that the German central bank was going to raise interest rates to protect the German currency and stifle inflationary pressures in the German economy. An increase in German interest rates and a revival of the deutschmark would put pressure on other European currencies in the run-up to European Monetary Union and could spark interest rate increases in other countries.
"The markets are facing lingering concerns about interest rates. The valuations of most markets are highly interest rate dependent," according to Mr Richard Kersley, strategist with Barclays de Zoete Wedd in London. Low interest rates and low inflation have driven stock markets strongly ahead in recent months by encouraging investors to move away from cash and into shares. But the speed and the strength of the bull run has made many investors nervous and there has been growing anticipation that a "correction" was in sight.
On Friday investors moved to take profits after the markets record breaking bull run.
But many market sources feel that the latest volatility will be more of a "correction" than a crash on the scale of the black Monday crash on October 19th, 1987, when the Dow lost over 20 per cent of its value in one day.
Friday's falls in New York and London must be placed in the context of the strong bull runs on international stock markets in recent months. The bull runs - heavy share buying - has driven the Dow Jones over the 8,000 points level and the FTSE over 5,000 points this summer. The Dow Jones reached an all-time high of 8,254.89 in the last week of July, giving a 28 per cent rise since the beginning of the year, and rising from a level of 7,000 points in just five months. In London share prices have risen by 27 per cent over the past year.
Some dealers asserted that there was nothing in the fundamentals to explain Friday's drop. "There have been no nasty shocks in the corporate sector, the bond market remains benign and economic data shows that inflation is under control," according to one US dealer. Explanations range from nerves and jitters to the "staircase theory" of Goldman Sachs dealer Ms Abby Cohen. She depicts the equity market as a series of steps, with periods of strong growth lasting a few months followed by periods of heavy volatility. This intense volatility happened last summer and again in early spring this year, when the US market dropped by almost 10 per cent on both occasions. But in the longer term, most dealers consider that the bull run is underpinned by strong economic fundamentals.
"It's been a correction waiting to happen. Nowadays this is the way that markets move. There is an instant repricing in which not much selling occurs but everyone wakes up to the repricing," according to Mr Chris Carter, managing director of global equity strategy at UBS. "It was just another Friday in August," one US dealer suggested, referring to the 156 point fall on the previous Friday (August 8th). Several factors contributed to last Friday's fall, he suggested, including the impact of the "double witching day" - the day when option holders decide on how to move their holdings.
